…about your deductibility question: the answer is NO!

During tax season, questions about the deductibility of company contributions come up year after year, most of which involve a plan sponsor’s wish to deduct a company contribution to their retirement plan. Despite their wishful thoughts, many times the answer is NO. In some cases, however, a NO answer is what they are hoping to hear, indicating that they did not lose a needed deduction indefinitely. If you are a plan sponsor wondering whether you will be entitled to a deduction for your employer contribution this tax season, read on. Hopefully, the NO answer you see below is the one you were hoping to get.

Must a contribution to a retirement plan be deposited prior to the filing of the sponsor’s tax return?

NO – To deduct the contribution on the tax return for the corresponding plan year, the contribution must be paid in full by the due date of the company’s tax return, including extensions, even if the company’s tax return is filed prior to the extended due date. In many cases, the company’s contribution has already been determined and confirmed, but the company still needs time to accumulate the funds for the contribution. As long as the extension has been properly filed, the return can be filed before the contribution is deposited. Similarly, if an extension has not been filed, the plan sponsor has until the original due date to make the contribution even if the return was filed before the deadline. However, some agents contend that if the plan sponsor files an extension but submits its tax return before the original due date, the extension becomes a nullity, and the contribution must be deposited by the original due date of the tax return not including any extensions. As a practical matter, many tax preparers, including Belfint, Lyons & Shuman, do not advocate filing a tax return prior to the actual deposit of the employer contribution. This is a conservative approach that protects the tax preparer from preparer penalties if a return including a deduction is filed and the employer contribution is never deposited or not deposited by the due date of the return including extensions, as applicable.

Must the contribution be deducted in the tax return for the plan year to which it relates?

NO – The Internal Revenue Code allows a plan sponsor to deduct an accrued contribution even if the employer is a cash basis taxpayer. Additionally, the ability to extend the due date of the employer return by filing for an extension provides the company up to six additional months to come up with the cash for the contribution, while still preserving the tax deduction on the prior year’s return. However, deducting the contribution on the tax return for the plan year to which the contribution relates is not mandatory. Plan sponsors can take a deduction in the year in which the contribution is deposited.

Can a plan sponsor adopt a plan for the first time after the plan year ends, but retroactively to the first day of the previous year?

NO – Even though the plan sponsor can deposit an accrued contribution in the year subsequent to the plan year, the plan must be in existence prior to the end of the year for which the plan sponsor is claiming a deduction. For example, the plan sponsor who wishes to start a new qualified plan for 2010 must adopt a plan document before December 31, 2010, even if the contribution is not made until September 15, 2011, the extended due date of the corporate tax return. A nominal deposit is sometimes required to open the account prior to December 31, 2010. However, SEP/IRAs can be established by the sponsor’s tax filing deadline including extensions and SIMPLE 401(k) plans must be established by October 1st of the plan year for which a deduction will be claimed or as soon administratively feasible if the business is established after October 1st.

Must a company have profits in order to make a profit sharing contribution?

NO – Code Section 401(a)(27) provides that a profit sharing plan can make contributions even if the employer had no current or accumulated earnings or profits. The plan must be a profit sharing plan. Conversely, self-employed individuals cannot make contributions for themselves if a year in which they have a net loss from self-employment, even if they make a contribution for common-law employees based on their compensation. However, self-employed individuals are required to deposit a contribution pursuant to a minimum funding requirement of a money purchase pension plan or a defined benefit plan, even in a year in which there is a net loss from self employment.

In the spirit of New Year’s resolutions and keeping a positive outlook, I hope to have a more positive blog in the future, but for now, the answer is NO.

Belfint Lyons Shuman is a Certified Public Accounting firm that focuses on conducting audits of 401(k) Plans, Profit Sharing Plans, 403(b) Plans, Taft-Hartley, collectively bargained and defined contribution plans, in Delaware(DE) and Philadelphia (PA). Our team has experience conducting 401(k), 403(b), and large plan audits for plans with 120 participants to those with over 8,000 total participants. We also have experience with first-year 401(k) and other plan audits.